A world of their own

Markets are now so sensitive to comments from central bankers that it is becoming increasingly difficult to tell what is more important: the comments or the reaction to them. Nor does the occasion, venue or manner of any one comment seem to make much difference. This week markets are likely to be dominated by Fed Chair Janet Yellen's almost saying something significant last Friday. The good lady is not noted for her specificity but she did say that rates are likely to go up by the end of 2015.  In contrast, the ECB these days are full of 'whatever it takes' stuff and Executive Board member Benoît Cœuré gave a big steer when he said the ECB would accelerate its QE programme before the Summer lull. Apparently Mr C now regrets saying this to a private audience of investment bankers and hedge fund managers but he must have guessed what they would go out and do! As a result of these interventions, the week ended with the dollar up against almost everything and the euro down, the rout in European sovereign bonds halted while US Treasuries wobbled, European equities revived while US equities fell back from their latest record highs. All of this occurred in the absence of any significant macroeconomic or geopolitical news. More of the same can be expected this week unless, of course, some other luminaries come out with some other pronouncement. Central bankers may be able to move markets but the awkward reality is that they seem decreasingly able to influence their domestic economies. On this basis, the Bank of England's inaction, as confirmed in the latest MPC minutes, seems highly appropriate.

Economics:  coming up this week

Flushed with success from last week's unusually accurate forecasts I 'confidently' present this week's:

The first cut of US Q1 GDP was sufficient of a shock to provoke a heated debate over its reliability and although the second cut will probably be revised upwards this will not be by enough to settle the arguments. The FOMC blames it on 'transitory factors' (notably the weather and West Coast port strike) but another batch of soft, or even merely softish, Consumer Confidence, durable goods orders and the Chicago PMI is likely to confirm that the US economy is not faring much better in Q2 (as already flagged by the Atlanta Fed Nowcast).

No major data is due from China this week but Japan's Industrial Production and Retail Sales simply must improve on the last few dreadful months if the first cut of Q1 GDP is for real. The CPI continues to be a worry as even the BoJ itself suspects that the recent increases are almost entirely due to last year's hike in Sales Tax.

In Europe the debate goes on between the half-full and half-empty glass camps. I must confess to being in the latter camp but have to take my hat off to Mario Draghi, who seems to be in both. On the one hand he congratulates himself on the success of QE and on the other harangues governments for failure to reform. The second cuts of Q1 GDP from most countries should be little changed but continuing deflation in Spain and Italy will be a dampener. Recent data from Germany has been mixed at best but Retail Sales and Gfk Consumer Confidence should be solid enough while various surveys elsewhere may show modest improvement. The best hope for EZ economy and by extension also for the UK) is that the benefits of cheap oil have only started to flow through. The same might be said about the softer euro but I remain sceptical that any benefits would last for long at a time when other countries are trying to depreciate their currencies.

Meanwhile, our own 'sceptred isle' if not exactly a 'fortress' looks like continuing to be 'blessed' by favourable data. Last week brought benign deflation (so far, see below), robust Retail Sales and solid public finances (supported, encouragingly, by buoyant tax receipts). This week should bring an upwards revision of Q1 GDP, a sharp improvement in Business Investment and another strong Gfk Consumer Confidence reading. Of course, there will also be more evidence of poor productivity and disappointing exports. It will be interesting to see how much money Chancellor Osborne is planning to throw at these problems.

Chis Bailey at Financial Orbit recently published a neat chart from Macquarie Research depicting the status of various economies around the globe. This version was first produced in March and may, therefore, seem a little optimistic, especially in respect of the US and China. Even if one does not agree with every detail the chart very usefully shows just how fragile many economies are currently: those upswings could easily be quite short-lived.   

Deflation watch in US and UK

Last week the CPI in the US clocked up a fourth successive month of deflation or zero inflation while the Core CPI (excluding Food and Energy) remained quite 'elevated' at 1.8%. This paints a very different picture from the FOMC's preferred measure of inflation, Core PCE which is still above 1% (see Wall Street Journal chart below). It could be quite reassuring as, after all, food and energy are essential and price decreases can be thought of as 'good' deflation and price increases on other items might be expected to boost Consumption and GDP. However, subdued Retail Sales since December suggest that in the US people are saving the 'dividend' from cheaper food and fuel. Therein lies the danger of 'bad' deflation, when consumers might delay all sorts of purchases leading to business restricting capital investment, hiring and pay rises, all of which would trouble the FOMC. In fact, the leading authority on the perils of targeting or tolerating zero inflation is none other than Janet Yellen's husband, Nobel laureate George Akerlof.

Deflation is a significant risk here too in the UK as prices of not just food and energy but also many other goods are falling. The position is somewhat confused by a sharp increase April Retail Sales vs. March and vs. April last year despite Easter being earlier in 2015. Moreover, in contrast to goods, prices for services prices appear to be holding up which could be a good sign In the service-dominated UK economy if it arises from a tightening employment market where wages could well be picking up.

In conclusion, given that growth and inflation are slowing in many economies both the US and the UK will need domestic demand to be strong if 'bad' deflation is to be warded off. Widespread inability to spend or persistent unwillingness amongst consumer can easily tilt any economy back into recession.

Algo watch

A potentially even darker side to the price movements last week to comments from Janet Yellen and Benoît Cœuré is that they seemed to be driven by the FX market. 

Of course, the FX market has always been volatile and inclined to overshoot but for some time now it appears generate huge cross-border hot money flows that are causing wild swings in other asset prices. Zerohedge, that most unrelenting of vitroloic market commentators, points the finger at banks and hedge fund algorithmic programmes as well at the central banks.

'........even banks scrambling to find any volume.... there is just one remaining "whale" source of dumb money to be front run: central banks. And as everyone knows, central banks trade mostly in the FX arena. And so, with the machines having firmly entrenched themselves in FX, and with the world's central banks engaged in an epic global currency war in an increasingly futile and self-defeating attempt to create demand by printing fiat money, we can expect a wild ride in currency markets going forward.....it means that there is no longer any space for retail investors in yet one more market, where market wide stop hunts, squeezes and momentum ignition have become the norm, as the only "traders" left are a few central banks and every single algo that hasn't cannibalized itself yet.'

It is hard to quarrel with this analysis of increasingly unhealthy markets where computers are programmed to identify and take out stop loss levels, which are essential not just for trading but also for prudent hedging and professional investment management. No wonder so many investors, institutional as well as retail, claim to be neither bullish nor bearish but neutral. How does one justify getting out when prices keep looking as if they are going to climb higher but one does not understand why or is even downright sceptica;

Greece: There's no money left

Liam Byrne may have paid a high reputational price for his attempt at humour in the note he left his successor at the UK Treasury in 2010 but there is no joke in Greece. The cupboard is bare at last.

As the crunch may come as soon as this week and blame bullets start flying around it may be worth remembering the games the various players have been engaged in.

The Federalists' (EU Commission, ECB and IMF) main objective has been to keep Greece in the EMU primarily as a matter of faith. However, both the ECB and the IMF face highly embarrassing losses if Greece defaults, whether or not they are compensated by the governments of the other EMU member countries. Mr Draghi is also in a second invidious position: the ECB is the Greek banks' lender of last resort and he is having to stretch the rules to keep them afloat. All these reasons help one to understand why Messrs Juncker, Moscovici and Draghi go around insisting EMU membership is irreversible and think the other countries are being illogical because they will have to pay up one way or the other. The Federalists game is, therefore, to prevent Grexit at any cost other than to themselves.

The member countries meet in the Eurogroup forum of finance ministers, of which the current chairman is Jeroen Dijsselbloem who is typically portrayed along with Germany's Wolfgang Schäuble as blocking any concessions to Greece. In fact, the reality is both more complicated and worse from a Greek point of view. There are plenty of other hardliners each with their own axe to grind. Even the most sympathetic to Greece on the surface- notably France and Italy-are very reluctant to dole out more money as they would be the second and third largest contributors.  Collectively, the Eurogroup seems to have given up on Greece and their game is to avoid any blame for Grexit. Greece itself is the obvious chief culprit but the Eurogroup also seem to be trying to paint the IMF as the hardliners on economic reform and the ECB as enforcers of the rules for supporting the Greek banks.

When Syriza took office not only was it in coalition with another party but it was itself a collection of factions on the left. Mr Tsipras has, therefore, done remarkably well not only to keep his government together but to maintain a high level of voter approval. However, he has done this by effectively adopting an all or nothing approach to the negotiations with the Federalists and the Eurogroup. In this he has been aided and abetted by Finance Minister Varoufakis who is an acknowledged expert in game theory. The Greeks might well have won the game with the Federalists but they look like losing the separate game with the Eurogroup.

The next moves are likely to be quite messy. Default on the next repayment instalment to the IMF may be avoided by the Eurogroup caving in at the last minute on partial release of bail-out money.  Alternatively, the IMF might grant a grace period. Immediate Grexit may be avoided by introducing capital controls or even some sort of interim parallel currency. The ECB may agree to extend the maturity of the Greek bonds it holds. Nevertheless, the only sure way of avoiding Grexit is capitulation by Mr Tsipras, which would bring down his government. This is what happens when the money really does run out.